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Options Trading - What is it?

by Staff Writer
23 Oct 2019 at 21:17hrs | Views
The process of trading stocks, shares, and securities, can be difficult enough and challenging enough to wear as a new trader. Within the world of trading, there are a number of different types of securities that can be traded.

What is a security? A security is essentially a class of investment. For example, if a trader were to be trading bonds, regular stocks, and penny stocks, they would be trading three different types of security. Another example of security is bonds.

Options are, whilst they do refer essentially to stocks, really just another type of class that you can invest in. Options can seem to be confusing at first glance, but when you understand the definition of them, trading them isn't much more difficult than trading any other type of security that you may do already. In this guide, we're going to take a look at exactly what options trading is, as well as how to use it to the best of its potential, and what it could do for your trading portfolio.

What Is An Option/Options?
In the world of trading, an option is essentially an agreement that allows someone to purchase something (as in a security) at a previously agreed price at any time up until the expiration of the contract. A lot of online brokers will offer options - this is another point to consider when choosing your broker. If you would like to be trading options, ensure that the broker you are considering opening an account with offers this.

Why is an option a good thing? For the purpose of an example, come out of the context of trading for a moment. Why is an option a good thing in any part of life? Well, it provides you with a choice that will usually give you more flexibility and the possibility of reduced risk in terms of the outcome. This rule applies in a very similar manner in terms of options trading. Not only does an option provide you with a reduced risk since you will know the price that you are purchasing at for definite, but it can also provide you with security and leverage.
You might be thinking at this point, how on Earth could an option provide me with leverage or protection in terms of trading? It's very simple. If you are considering investing in a stock that may or may not decline during the time that you are holding it, you run the risk of losing money on that investment. At the same time, you might think the other way - if you are considering investing in a stock at one particular time that you think will rise fairly dramatically in the close coming time, you could use an option to ensure that you can still purchase that more valuable stock at the same lower price you considered it at. There is no doubt that options can pose a risk to an investor, but similar to anything else in the stock market, they can also pose as a great safety net.

Derivatives - What Are They And How Do They Relate To Options?
As we have already said, even though an option is a type of security, it is essentially a branch of a bigger group of security type known as derivatives. A derivative is really what it says in the name, it's something that comes from another thing. To make a more realistic example, petrol is a derivative of oil and oil is a derivative of the Earth. In the case of options in trading, an option is a derivative of another security whose value is dependent on that of which it is derived.
Different Types Of Options - Call vs Put
As we have previously said, an option is merely another type of security that can be invested in. Similar to a stock, share, or bond, It can be invested in with the hope of making a return. There are, however, different types of options that are available.
A Call Option - A call option gives you, if you are the owner of the option, the right to purchase a stock. A call option can be great, as it means that you are guaranteed to be able to purchase the stock that the option is for at that particular price, as long as you make the purchase before the term of the option expires.
A call option can be very advantageous, should the value of the stock rise massively, you will still be able to purchase that stock at the price agreed on the option. This means that should you decide to make the purchase, you will be able to sell off the stock immediately at that current high price and immediately make an impressive return.

A Put Option - Differently to a call option, a put option allows the holder of the stock to sell that stock at a previously agreed price. A put option can also be a very effective way of securing a safety net, just like a call option. A put option allows you to protect whatever you are covering with it and your own investment against making a major loss, even if its physical value were to change.

What Are The Advantages Of Using Options When Trading?
Options should be essentially thought of as an insurance policy. They exist to reduce the risk of an investment without raising the initial cost of that investment by all that much. Even if you aren't worried about an investment losing money, options can be of great advantage. They are often a means of insurance against an investment that you have made going downhill, and they can be rewarding if an investment that you have made turns out to be a very good decision.

If you have an option agreement, you will always be able to buy or sell that security at the agreed price on the option. Of course, it could go either of two ways - you could end up with an agreement that allows you to to purchase a security for a lot less than it is really worth, or you could have an agreement that allows you to sell a security for more than it is worth at that time.

Source - Byo24News